Exporting Taxes Threatens State Economies

Mr. Semmens is an economist for the Laissez Faire Institute in Tempe, Arizona.

The most popular tax is one paid by someone else. Thus state legislators, in their quest to raise spending without angering local taxpayers, are devising more and more schemes to “export” taxes to out-of-state residents.

These include higher taxes on goods and services most frequently purchased by tourists (e.g., taxes on hotel rooms and car rentals), higher taxes on extraction industries (e.g., oil production and mineral mining), and efforts to collect more taxes from business income earned outside the state through “unitary” taxes. In each case, the targeted taxpayers live outside the taxing jurisdiction, so they won’t be able to express their dissatisfaction at the polls.

Economists, however, point out that there are no “free lunches.” Everything has a cost. The apparent free lunch to be had from attempting to export the tax burden is illusory. The short-term gains are more than offset by larger long-term losses. What the proponents of exporting taxes fail to see is that they are also exporting the enterprises and job opportunities that could help their state grow and prosper.

When the Constitution was written in 1787, its authors were careful to include a clause prohibiting the federal government from imposing taxes on exports (Article I, Section 9, paragraph 5: “No tax or duty shall be laid on articles exported from any State”). They knew that a tax on a state’s exports could devastate that state’s economy. They didn’t bother to similarly restrict states from taxing their own exports because, apparently, they didn’t anticipate that any state would be so foolish.

Attempting to export a tax puts a state at a competitive disadvantage when it comes to importing income and wealth. While it may well be true that nonresidents are nonvoters and as such probably won’t have much impact on state and local elections, they are still consumers. Unlike the local taxpayers who may have little choice but to pay the higher taxes imposed by their legislature, the out-of-state taxpayers may more easily take their busi ness elsewhere.

Consider the dilemma of the in-state firms that are supposed to export a tax to their out-of-state customers. If the tax is added to the price of the exported product (as state legislators seem to assume it will be), competing products from other, lower-taxed locations will have an advantage. Tourist attractions in these other locations will become slightly more alluring. Manufactured goods produced elsewhere, perhaps in a foreign country, will gain a small price edge on every unit offered for sale. Consequently, sales revenue for the in-state businesses will fall. Lower revenues mean a smaller business operation, fewer employees, and less economic growth.

On the other hand, if the in-state businesses absorb the tax in order to maintain competitive prices in out-of-state markets, then their profits will fall. The higher profits of out-of-state businesses will become more attractive to investors. Investment capital will tend to flow out of state, which will mean less growth and fewer economic opportunities for would-be in-state employees.

Some proponents of export taxes argue that the rates are too low to have any effect on economic decisions, or that the targeted taxpayers are “locked in” anyway. The locked-in thesis has some plausibility. A mine, for example, is where it is because that’s where the ore is located. A tax won’t change that. However, a tax will change the relative profitability of the firm or the salability of its output. These small effects at the margin can have large long-term effects on business expansion and choice of business location. Mines in other locations will gain a larger market share. New mines are a bit more likely to be established in lower-taxed locations. A few percentage points of difference in the short run grow into millions of dollars and thousands of job opportunities lost in the long run.

Whether taxes are exported or not, they still remove funds from the private sector. The money that goes into export taxes will be unavailable to invest in tourism, mining, or other businesses, further hurting the local economy.

Economic growth rarely comes in huge leaps forward. More typical is the continuous compounding of modest single-digit growth rates. In a multi-billion dollar economy, a reduction of just a fraction of a percent in the return on investment or growth rates can amount to the loss of billions of dollars of wealth and millions of job opportunities over a single generation.

Both equity and efficiency point away from the policy of attempting to export taxes. A government that rejected the “free lunch” appeal inherent in the exportation of taxes would better serve its constituents. If the residents were disabused of the notion that someone else is going to pay their state government’s bills, they would be less tolerant of waste and excessive spending.

The ethos of contemporary tax policy is misguided and, in the long run, self-destructive. A revival of a “no taxation without representation” policy would be more equitable and more profitable for those who adopt it.

THE FREEMAN

EMAIL UPDATES

* indicates required

Email Address *

CURRENT ISSUE

December 2014

Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.